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Fed Shift Leaves Experts Blind, Complicates Central Bank’s Job

Posted by commendatori on January 28, 2009

By Scott Lanman

Jan. 28 (Bloomberg) — Investors will have a tougher time assessing Federal Reserve policy when officials today replace interest rates with emergency credit programs as their main tool for steering the economy.

Without rates as their main policy gauge, Chairman Ben S. Bernanke and the Federal Open Market Committee also will find it more difficult to anticipate the impact of their statements on financial markets during the worst credit crisis in seven decades.

“It’s not only harder for them to predict, but it’s harder for them to get traction” from the Fed’s $1 trillion effort to revive credit, said Keith Hembre, a former Fed researcher who is now chief economist at FAF Advisors Inc. in Minneapolis.

The new focus on changes in the size and composition of the central bank’s assets makes it harder for policy makers to revive confidence in bond and stock markets, Fed watchers said. Such confidence is needed after financial shares tumbled 29 percent and unemployment hit a 16-year high since the Fed cut the main rate to a record-low 0.25 percent or less on Dec. 16.

The central bank, while pursuing its policy of easing credit, probably won’t alter borrowing costs today and for the remainder of 2009, according to the median forecast of analysts surveyed by Bloomberg News.

That means analysts can’t base their predictions for Fed decisions on a simple interest rate benchmark for the first time since the FOMC began releasing policy statements in 1994.

“It’s not multiple-choice anymore,” said RBS Greenwich Capital chief economist Stephen Stanley, a former Richmond Fed researcher. “It’s essay questions.”

The FOMC will release a statement at about 2:15 p.m. in Washington at the conclusion of a two-day meeting.

Reliable Measure

Policy makers lost one reliable measure of market sentiment in September when futures ceased to be an indicator of investor expectations for interest rate decisions.

The Fed had failed to align its policy target rate with the rate banks charge each other for overnight loans. Traders had looked at the so-called federal funds rate when determining their bets on what the policy makers will do.

Central bankers have yet to dispel investor uncertainty by announcing targets for the size or composition of its balance sheet beyond current programs, such as plans to purchase mortgage bonds and housing-finance totaling $600 billion. Assets held by the Fed have more than doubled to $2.04 trillion over the past year.

‘Communications Challenge’

Bernanke highlighted the Fed’s difficulty of transmitting its intentions in a Jan. 13 speech, saying “the lack of a simple summary measure or policy target poses an important communications challenge.

“To minimize market uncertainty and achieve the maximum effect of its policies, the Federal Reserve is committed to providing the public as much information as possible about the uses of its balance sheet, plans regarding future uses of its balance sheet and the criteria on which the relevant decisions are based,” he said at the London School of Economics.

The FOMC statement in recent years has followed a clear structure: After a decision on the main interest rate came a paragraph on the economy, one on inflation and another one on the policy stance. The release usually ran about 100 words, fitting on a single page.

Emergency Lending

After the December meeting, the central bank added a five- sentence, 149-word paragraph explaining its decision to conduct policy through its emergency lending programs.

The Fed also shelved its main policy tool, saying it’s likely to maintain “exceptionally low levels of the federal funds rate for some time.”

Today, the central bank may once again break with usual practice as it pushes ahead with the most aggressive efforts to reinvigorate credit markets since World War II, Fed watchers said.

“With the Fed likely attempting to summarize progress on several different credit-easing programs, it does make the job of giving the particular wording for each program particularly important and perhaps even more difficult than normally crafting a statement,” said Dean Maki, co-head of U.S. economic research at Barclays Capital Inc. in New York.

“When the language becomes less specific to the path of the federal funds rate, it does raise the risk of misinterpretation,” said Maki, a former central bank economist.

The Fed will probably still describe the U.S. economy as “gloomy” and say inflation isn’t a concern, Stanley said.

Jobs Cut

U.S. employers cut 2.6 million jobs last year, the most since 1945, pushing the unemployment rate up to 7.2 percent in December, a year after the recession started.

Home prices in 20 U.S. cities declined 18.2 percent in November from a year earlier, the fastest drop on record, according to the S&P/Case-Shiller index.

The Fed governors and regional-bank presidents today will provide new forecasts for gross domestic product, inflation and the unemployment rate.

The central bank will release those predictions as part of the meeting minutes on Feb. 18. Bernanke will also appear before Congress for semi-annual testimony on monetary policy next month.

To contact the reporter on this story: Scott Lanman in Washington at

Last Updated: January 28, 2009 00:01 EST



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